Introduction
In the interconnected global corporate ecosystem, corporate guarantees are a pivotal instrument for facilitating group financing, bolstering the creditworthiness of subsidiaries, and securing operational commitments. These guarantees, typically categorized as financial (assuring repayment of loans) or performance (securing contractual obligations), generate fees that have become a significant point of contention in international taxation. The core debates revolve around their correct characterization under Double Taxation Avoidance Agreements (DTAAs), the determination of their Arm's Length Price (ALP) for transfer pricing, and their treatment under Goods and Services Tax (GST). This article synthesizes judicial precedents and regulatory provisions to provide a comprehensive overview of this complex landscape.
1. Taxability under DTAAs: The Characterization Conundrum
A primary dispute is classifying income from corporate guarantee fees under specific articles of a DTAA. Tax authorities often contend it is interest, arguing the fee is ancillary to a debt arrangement. Taxpayers counter that a guarantee, being a contingent obligation without an actual lending of money, lacks the essential character of "interest" as defined in treaties. Alternative positions are to treat it as Fees for Technical Services (FTS) or Business Profits. If classified as business profits and in the absence of a Permanent Establishment (PE) in the source state, the income would not be taxable there.
Judicial trends, however, have consistently rejected these characterizations, often funneling such income into the treaty's "Other Income" article, the application of which varies dramatically.
2. Judicial Precedents: A Treaty-Specific Journey
2.1 Johnson Matthey & India-UK DTAA: Taxation in the Source State
In Johnson Matthey Public Ltd. Co. v. Dy. CIT, the taxpayer argued the fee was interest or business income. The Delhi ITAT and later the Delhi High Court rejected both. The ITAT held that a guarantor, not being a party to the primary loan contract, cannot be said to earn "interest." It also ruled that providing guarantees to subsidiaries was not a regular business activity. The fee was not FTS as no technical/consultancy service was rendered. Consequently, Article 23(3) of the India-UK DTAA applied, which allows taxation of "other income" in the state where it arises. The courts held the income accrued in India as the obligation to pay was triggered by the subsidiary's actions in India, a ruling ultimately upheld by the Supreme Court.
2.2 Dynamic Drilling & India-Singapore DTAA: Dual Taxation Rights
In Dynamic Drilling & Services (P.) Ltd. v. ACIT, an Indian entity received a performance guarantee commission from its Singapore AE. The Revenue argued it was business income, not taxable in Singapore due to no PE, thus denying a foreign tax credit in India. The ITAT disagreed, stating the one-time guarantee fee was not business profit. It invoked Article 23 of the India-Singapore DTAA, which permits items of income not expressly mentioned in other articles to be taxed under the domestic laws of both states. Therefore, tax rightly withheld in Singapore was eligible for credit in India.
2.3 Lease Plan & India-Netherlands DTAA: Potential Non-Taxability
In Lease Plan India (P.) Ltd. v. Dy. CIT, the Delhi ITAT analyzed the India-Netherlands DTAA. It concluded the guarantee fee was neither interest nor FTS. Crucially, as the India-Netherlands treaty at the time lacked an "Other Income" article, and with no PE in India, the income could not be taxed in the source state under Article 7 (Business Profits). This highlights a scenario of potential non-taxability in the source state.
2.4 Daechang Seat & India-Korea DTAA: Exclusive Residence State Taxation
Contrasting with the UK treaty, the Chennai ITAT in Daechang Seat Co. Ltd. v. Dy. CIT applied Article 22(1) of the India-Korea DTAA. This clause grants the exclusive right to tax "other income" to the resident state (Korea). Therefore, the guarantee fee was not taxable in India.
2.5 Analysis of "Other Income" Articles
The divergent outcomes hinge entirely on the treaty wording:
India-UK, Japan, USA: "Other income" may be taxed in the other (source) State.
India-Singapore: Income may be taxed under the domestic laws of both States.
India-Korea: "Other income" shall be taxable only in the (resident) State.
India-Netherlands (at the time): Absence of the clause led to non-taxability in source state without a PE.
3. Transfer Pricing: Guarantee as an International Transaction & ALP Benchmarking
3.1 International Transaction
Both the Income-tax Act, 1961 (via Explanation to Section 92B) and the new 2025 Act explicitly include "guarantee" within the definition of an "international transaction" between Associated Enterprises (AEs), settling prior judicial ambiguity.
3.2 Determining the Arm's Length Price
The ALP of guarantee commissions is highly contentious. Tax authorities often benchmark using rates charged by banks (e.g., 2-3%). However, courts have scrutinized this approach.
Safe Harbour: Rule 10TD prescribes 1% p.a. for guarantees over ₹1000 crore, applicable only if the taxpayer opts for the safe harbour regime.
The Everest Kanto Precedent: This case is seminal. The TPO proposed an ALP of 3% based on bank guarantees. The Mumbai ITAT (upheld by Bombay High Court) rejected this, stating:
A corporate guarantee by a holding company to its AE is fundamentally different from a bank guarantee issued to an unrelated party. Factors like risk assessment, relationship, and business interest are distinct.
The TPO's assumption of inherent risk was unsupported by facts, especially when the borrower had pledged assets.
An internal Comparable Uncontrolled Price (CUP) was available: the assessee paid its bank 0.6% for a guarantee. Charging its AE 0.5% was held to be at ALP, with minor differences acceptable.
Crux: Blind application of high bank rates is unjustified. ALP must consider actual risk, cost, and internal benchmarks. The ruling validates lower or nil charges where justified by facts.
4. GST Implications on Corporate Guarantee Charges
The GST regime provides specific valuation rules for related-party transactions.
Rule 28(2) of CGST Rules: For a supply of services by way of providing a corporate guarantee on behalf of a related person located in India to a bank/financial institution, the value is deemed to be 1% per annum of the guarantee amount or the actual consideration, whichever is higher.
Full Input Tax Credit (ITC) Clarification: The CBIC Circular No. 210/4/2024-GST dated 26.06.2024 significantly modifies this for import of services. If the Indian recipient is eligible for full ITC, the value declared in the invoice can be deemed the open market value. If no invoice is raised, the value can be deemed "Nil." This reduces the compliance burden and potential tax cost for purely internal group transactions where ITC is not blocked.
Export of Services: The provision of a guarantee by an Indian entity to a foreign AE is treated as an export of service (subject to conditions under Section 2(6) of the IGST Act), generally being zero-rated.
Concluding Remarks
The tax treatment of cross-border corporate guarantee fees is a nuanced domain dictated by the specific DTAA applicable. Jurisprudence firmly establishes that such fees are generally not interest, business income, or FTS but are assessed under the "Other Income" article. The taxing rights—whether with the source state, resident state, or both—are entirely treaty-dependent, necessitating a meticulous treaty analysis.
For transfer pricing, the Everest Kanto principle is key: benchmarking must be realistic, risk-based, and should leverage internal CUPs where available, moving away from mechanical adoption of bank rates. The introduction of safe harbour provides certainty for large guarantees.
On the GST front, while a deemed valuation of 1% exists, the recent circular offers pragmatic relief for transactions within fully credit-eligible groups, aligning the valuation with the economic reality of intra-group support.
In essence, multinational groups must adopt a holistic approach—analyzing treaty texts, corroborating transfer pricing with robust functional analysis, and complying with evolving GST valuations—to navigate the tax implications of corporate guarantees effectively and mitigate litigation risks.
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